By: Hima Mehta
What is a 401(K)?
A 401(K) is a retirement savings plan sponsored by employers. It allows you to move a portion of your paycheck into an investment account to have money available during your retirement years. Additionally, if you fall in a higher tax bracket and choose to put before-tax money into a 401(K), you can save on current taxes.
Within the 401(K) plan you have the option of contributing the money before-tax with a Traditional 401(K), or after-tax with a Roth 401(K). Some employers also offer a funds match when you contribute, offering additional income you can use for retirement. Even if you were to leave your employer, you can roll over your 401(K) to your new company or you can start a separate account with a brokerage company to continue your investment.
Choosing a Retirement Savings Plan
Always research different plans your company may offer and whether they match funds. Consider age and income while planning for your retirement and considering and investment plan. Set savings goals according to what you imagine for your future. There are many ways to save for your retirement, but a 401(K) allows employees to put more money aside compared to an Individual Retirement Account (IRA).
What are the Differences Between a Roth 401(K) and a Traditional 401(K)?
|Roth 401(K)||Traditional 401(K)|
|Contributions, or adding funds to the 401(K)||After-tax dollars are contributed within the calendar year||Before-tax dollars are contributed within the calendar year|
|Annual contribution limit||$19,000 employee contribution
$25,000 if age 50 or older
|$19,000 employee contribution
$25,000 if age 50 or older
|Taxation at contribution||No income tax deduction at the time of contribution. Money added to the 401(K) each year is still taxed at regular income tax rates.||Income tax deduction is allowed at the time of contribution. Money added to the 401(K) can be deducted from your income taxes.|
|Taxation at distribution, or when funds are withdrawn from the 401(K)||After the age of 59.5 years, qualified distributions are tax-free. You must begin taking distributions by age 70.5 or earlier.||After the age of 59.5 years, distributions are taxed at current income tax rates. You must begin taking distributions by age 70.5 or earlier.|
|Distribution fees||Withdrawals have no taxes or penalties if taken five or more years after the first contribution. Funds withdrawn before that date are subject to a 10% penalty.||There is a 10% penalty on all funds withdrawn before the age of 59.5 years.|
|Income thresholds: Who can qualify?||No limitations: Everyone can participate||No limitations: Everyone can participate|
All employees should explore whether their employer offers 401(K) plan contributions and a match option. It is beneficial for employees to put money in their 401(K) if the employer has a match option since that is additional income you are getting from the employer. Consult your CPA or accountant for tax planning services so you can plan accordingly.